I saw an offer the other day, on the web of course, something with a normal price of $495.00 knocked down to $19.95. I thought to myself that nobody would ever buy something offered with that patently absurd insult to intelligence.
But I’m pretty sure people do. I learned that the hard way.
I once decided to overrule a direct mail marketing expert, who I had hired, and send out a direct mail campaign for a software product priced at $100 instead of $99.95. He was a real expert too, but I thought I knew my market, and my customers, better than he did. I didn’t.
And spam? Every so often I wonder how spam still exists. Who can be so naïve as to click on those emails and buy the stupid stuff the spammers offer? Is there anybody left? Obviously the answer is yes, because the spam keeps coming. So somebody buys it, right? Or else it wouldn’t be worth sending?
(Note: This was first posted last week on the Amex OPEN Forum. I’m reposting it here, with permission, for the convenience of my readers here. Tim.)
All the years I’ve been following business, strategy and small business—from the late 1970s through today—I’ve always wished for a magic formula for proper pricing. What’s the right price for this service? How should you price a new product? In teaching, writing and answering emails, this question comes up all the time. And, much as I’ve looked for the right answers, they aren’t at the back of the book.
Pricing is magic. There is no formula that works for you, or me, or any generalized group. You set your pricing as a matter of situation, strategy, costs, competition, weather, instinct and all of the above.
While I can’t really tell you how to set your pricing right, I can at least share something that I’ve learned—in classrooms, in making mistakes, in growing my own company—about how NOT to set your pricing.
Here are the three most common pricing mistakes that I see. And, just to be clear, while I wish I could drum up some rigorous research to back me, this is based on anecdotal evidence, common sense, and three decades of dealing with business problems.
1. Trying to be the lowest price provider
One of the most damaging cliches in business is the idea that the lower price gets the highest volume. The whole lower price equals higher volume idea, a fundamental law of economics, is for undifferentiated commodities, not your business or mine.
Successful lowest-price strategies are unusual. They usually take a lot of capital, resources and visibility. What works for Costco and Walmart doesn’t work for the corner store, some discount airlines and gasoline stations, but those strategies usually require a lot of capital and very large scale implementation.
2. Mixing your pricing message
We forget way too often—and too soon—that price is the most powerful marketing message you have. Do you think people don’t buy your work because it’s too expensive? But isn’t it worth it? Don’t you believe in it? It’s about positioning. How are you different from the others? Is what you sell better than the one across the street? Does your price say so?
Would you get a root canal from the cheapest dentist in town? Would you save money by buying two-day-old sushi? And why isn’t the cheapest car made the most popular?
I lost a consulting job I really wanted once when I bid $25k for it and a competitor bid $75k. The guy who gave me the bad news told me everybody liked my proposal, but they wanted the best, so they went for the higher price.
What would you rather have for dinner: a $1 hamburger or a $20 steak? We used to go to a restaurant that had really good food and surprisingly low prices. But I often wished they’d raise their prices so we didn’t have to wait 45 minutes or more to get a table. And guess what: they no longer exist. They went out of business. Do you think pricing had something to do with that? I do.
3. Underestimating real costs
Businesses go under when they run out of money. The research on how they run out of money is confusing and ambiguous, and there are rarely single identifiable causes. Still, just betting on what I’ve seen with my own eyes through a lot of years, I think businesses frequently run out of money because they underestimated real costs.
We talk a lot about gross margin in business analysis. That’s your selling price minus your direct costs. So if you buy that widget for $2 and sell it for $6, then the gross margin is $4, and your gross margin percent is 67 percent.
Unfortunately, focusing just on gross margin isn’t enough. Aside from the $2 you paid for that widget, there are all those other expenditures, including your rent, your payroll, your insurance, your electric and water bill, all of your marketing costs, and lots of hidden costs, like the computers and software you’ll need to buy next year. We call that overhead and tend to forget it. Which is a shame, because a lot of businesses forget about it all the way to the business grave. You run out of money.
True story: back in my business planning consulting days, 1983-1994, Apple computer was by far my best client. I worked for the Latin America group, then Apple Pacific, then Apple Japan, and a bit for Apple USA and Apple Europe. I facilitated a lot of business plans, and did market research and some country plans, single-issue plans, and so on. I also worked with other clients, of course; but I depended on Apple.
I priced my consulting by the engagement. The client would describe the job, I’d write a proposal, set a pricing and billing schedule, and then stick with it.
There was one person, among several dozens I worked for, who had a pattern of scope creep: meaning that after we’d agree on what was to be done for how much money, as I delivered the work in stages, he’d consistently want more than what had been agreed. It was always “But what about this” and “have you followed up on that?”
And it’s hard, as you know if you’re in this kind of expert business, to tell the client too often that what he or she is asking for is beyond the scope of the project. Sure, you have to sometimes, but it’s never easy.
So here’s my nugget about pricing: after I worked with that person and had that happen once, I was concerned with the problem. The second time he asked for a job, I wrote the proposal much more carefully, trying to block out scope creep; but it happened anyhow. The third time he asked, I calculated what I would normally charge, and tripled it.
That pricing idea worked. I didn’t want to have an enemy embedded among my favorite clients. So he didn’t accept that proposal, and I didn’t do any more work with him after that. But we remained on good terms at meetings, and he didn’t lobby against me when my name came up.
The worst I heard he said about me, second hand, was “how can you guys work with him so much? He’s really expensive.” And that was fine with me.
I admit it. Pricing is often baffling to me. Test your pricing IQ by answering these 10 simple questions.
1. Why is an iPhone application expensive at $4.99 but a magazine can sell for $6.95, and a no-frills 20-ounce cup of coffee for $2.50 without anyone getting up in arms?
2. Why is a gallon of gas expensive at $3.00 when a gallon of bottled water costing $4.00 isn’t an outrage ?
3. Why is a Sunday newspaper just fine at $1.00 and up but a news website way too expensive at $2.99 per month?
4-5. Why are great applications like Google Earth or Evernote free? My generation was taught to mistrust the man in the trench coat offering free candy. Should we worry?
6. Why do we accept advertising without question in newspapers and magazines and most television, but not in an iPhone app we paid $2.99 for?
7-10. Why do we assume email is free? Why do we pay hundreds of dollars for one productivity suite, or nothing for another? Why do we assume content has no value, and why do content providers give it away? Why do we assume anything we can copy has no value, or that copying isn’t stealing?
Pricing is magic. And baffling. And to score this test, make something up. I have no idea.